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07/18/2017

How Is Inherited Real Estate Taxed?

The home's value is generally determined through an appraisal that would establish the home's fair market value.

If you have a home valued at over $1 million, it may sell close to that amount. Let’s say that you’re single and are 80 years old. You live with your widowed sister. Your will instructs that your sister should have life ownership when you pass and then it is left in trust for nieces and nephews. What would their tax bill be?

Fair market value, in these circumstances, is typically defined as "the amount at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy, and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts."

The transfer of a life estate to the sister, followed by placing the home in a trust for the nieces and nephews, would mean they’d have an inheritance tax liability in New Jersey. The sister is a Class "C" beneficiary under the state’s inheritance tax laws, and the nieces and nephews are deemed to be Class "D" beneficiaries.

Generally, Class "C" beneficiaries have a $25,000 exemption and anything over that exemption is taxed at 11% on the next $1.075 million. The rates then go higher as the amount increases. Transfers to Class "D" beneficiaries are taxed at 15% on the first $700,000 and 16% on amounts exceeding $700,000.

This is unlike the situation where a beneficiary receives a readily determinable amount at death. In such cases, the tax can be calculated easily by reference to the beneficiary classes and applicable tax rates. But in this scenario, the value of the interests the beneficiaries will ultimately receive is uncertain.

However, state law provides a solution for this situation: the estate and the New Jersey Division of Taxation may use the "Compromise Tax" procedures to agree upon an inheritance tax liability. The calculation of the compromise tax is based upon actuarial factors according to the life expectancy of the current beneficiary, his or her beneficiary class and the relative probability of assets passing to the remainder beneficiaries and their respective beneficiary classes. In most cases, the taxpayer offers a proposed compromise on the inheritance tax return for consideration by the Division, based on the taxpayer's assessment of the most probable outcome.